Armenia needs to reform its business environment

Armenia’s government budget for 2017 is rather economical. When devising it, the government tried to ensure savings and cut costs. Was this decision reasonable? How can external factors affect the performance of the country’s main financial statement? Is it possible to attain the expected economic growth rates given the high fiscal debt? Alisher Mirzoev, Director of the Project Group for Financial Credits at the Eurasian Fund for Stabilisation and Development (EFSD) managed by EDB, answers these and other questions in an exclusive interview to ARKA.

Mr Mirzoev, Armenia’s budget for 2017 is an austerity budget with all possible costs seriously cut. Do you think this is a correct decision and why?

We think this is a correct decision. It demonstrates the Armenian government’s commitment to the current fiscal rule aimed at maintaining fiscal and debt sustainability. The rule is that if the debt exceeds the threshold of 50% of GDP, the fiscal deficit for the next year must be not higher than 3% of the average nominal GDP in the previous three years. In 2016, the government debt grew to 51.9% of GDP. Therefore, in accordance with the rule and above calculations, the fiscal deficit in 2017 must not exceed 150 million drams and this, as preliminarily estimated, should result in its reduction to 2.8% of GDP compared to 5.6% of GDP in 2016. Keeping up with the rule will help to ensure transparency of the government’s economic policy and, accordingly, predictability in the economy as a whole. In addition, the continuous reduction in the fiscal deficit in the medium term will not only help to maintain the country’s debt sustainability, but will also reduce the risk that private investments will be displaced.

What external factors can affect the country’s fiscal performance and overall economic situation?

One of the main external factors may be a slower recovery of the Eurasian Economic Union economies, especially Russia. The main risk for fiscal performance associated with this factor – a slowdown in domestic tax revenues – is indirect. These are, in the first place, profit and income taxes that may decline because of economic slowdown, especially as a result of shrinking export growth rates and foreign investment inflows, and a slower recovery in money remittances. The declining aggregate imports to the EAEU countries will affect Armenia’s fiscal performance as a result of a decrease in the share of customs duties in the structure of tax revenues. Another factor affecting the budget is the continuing risk of the further decreases in copper and other raw material prices, which will cut down royalty revenues.

The most pressing among the destabilising geopolitical factors is instability in Nagorno-Karabakh. An aggravation of this regional conflict can lead to an upsurge in non-budgeted military expenditure, to the detriment of other budgeted spending, and the worsening of political and economic uncertainty.

How do you assess Armenia’s approved economic growth rate of 3.2% for 2017? Will the government manage to attain it and ensure subsequent development?

Starting from 2013, the main driver for economic growth in Armenia has been exports. This was ensured, to a significant extent, by export diversification and reductions in tariff and non-tariff barriers after Armenia’s joining the EAEU, which stimulated activity in the mining and jewellery sectors. The emptied niche of agricultural supplies in Russia, due to sanctions against Turkey, also stimulated exports. We forecast that in 2017 economic growth will slow down because of the high base effect, Russia’s partial abolition of sanctions against Turkey, and the persistently low prices of Armenia’s exports.

At the same time, consumer activity can liven up to an extent, due to recovered positive growth in money remittances. In particular, net money inflows received by the banking system in January 2017 were more than two times higher than the year before. The proposed construction of major infrastructure projects with the involvement of private foreign investors can give an impetus to investments in fixed assets. In aggregate, these factors can stimulate greater GDP growth compared to 2016, although it will be difficult to attain the indicator approved by the authorities. We forecast that Armenia’s economic growth in 2017 won’t exceed 2.5%. All other things being equal, with the decrease in taxes, this will form a fiscal gap of about 0.2% of GDP. In this case, not to break the fiscal rule, budget expenditure will need to be reduced equivalently.

Despite the fact that fiscal consolidation will gradually lead to greater debt sustainability, its short-term effect on economic growth can be negative. For example, if fiscal revenues decline and this is compensated by an additional reduction in capital government spending, the short-term negative effect on GDP growth rates may be significant. Under any scenario, the government should focus on structural reforms and stimulating private investments as the main factors conducive to the attainment of long-term sustainable growth. This policy will be an effective addition to the fiscal and monetary measures already fulfilled by the government. We deem that short-term measures to stimulate stable growth without structural reforms have already exhausted their potential.

What preconditions should Armenia create to promote economic development in the coming years?

To ensure sustainable long-term growth, the most important thing is to reverse reductions in investments in fixed assets that have been observed since 2009. As I said already, these are, in the first place, private investments, the growth of which depends, to a significant degree, on consistent structural reforms. Although in recent years Armenia has been among the CIS leaders in terms of institutional environment and has improved its ratings, the need for reforms to improve its business climate and increase market transparency for the development of competition and economic diversification remains high.

The EFSD’s financial credit supports the Armenian government’s efforts aimed at improving the investment climate by easing the doing of business and reducing taxpayers’ administrative burden. In particular, the first two tranches of the financial credit made it possible to reduce the time for getting electricity by one month. The time for dealing with construction permits was reduced by more than two times (from 83 to 35 days). Construction procedures are now available online. The ongoing digitalisation of geologic archives will help to improve awareness among potential investors in the mining sector. Electronic tax filing and the creation of a personal property register have helped to reduce businesses’ transaction costs and improve access to bank loans. When the tax code takes effect it will form a single legal framework that will eliminate inconsistencies between the laws and improve transparency for all businesses.

Armenia has significantly increased the government debt for a number of reasons and it now exceeds 56% of GDP and includes the government and Central Bank’s debts. How can this influence the further development and the country’s budget?

The influence of the debt on the budget is evident – fiscal expenditure on interest (the immediate effect) and principal payments (the medium or long-term effect) are growing. Over the last two years, the government debt has increased from 39.4% of GDP in December 2014 to 51.9% of GDP as at the end of 2016, resulting in greater debt service costs. While in 2014 the respective government spending accounted for 5.6% of all current fiscal expenditure, or 1.3% of GDP, in 2016 it was 7.8% and 1.9% of GDP respectively. In 2017, according to the approved budget, these figures will grow to 8.8% and 2.2% of GDP. If the debt increases at the same rates further, Armenia’s debt sustainability will be at risk and this may result in that loans will become more expensive, aggravating pressure on the budget.

With the growing debt burden, capital accumulation has been slowing down since 2009. This combination may have a fundamentally negative effect on the further economic development and the government budget. Here I need to point out that the slowdown in capital accumulation was due, to a significant degree, to the GDP structure optimisation in favour of tradable sectors with reductions in construction, which had been overblown during the pre-crisis years. At the same time, increases in investments in machinery and equipment are low (and sometimes negative) and this threatens long-term growth. In this connection, we encourage the Armenian government’s ongoing assessment of the effectiveness of all investment projects. Among other things, it will help to adjust the effectiveness criteria for future borrowings.

Does Eurasian Development Bank plan to extend additional support to the government budgets of its member countries and Armenia in particular?

In accordance with the agreement on the EFSD financial credit, this year we plan to provide the third tranche of the credit amounting to US $100 million, which approximates 1% of GDP. This is rather significant support from a single donor. The cut-off date for assessing compliance with the tranche conditions is 1 October. After we receive a report on compliance with the conditions precedent from the Armenian government and complete our assessment, the issue will be submitted to the Fund’s Council. The decision on the extension of the tranche will depend on compliance with the conditions.

The EFSD provides financial credits to the member states based on their applications. As at today, the EFSD did not receive any new applications from the member countries, including Armenia, for fiscal support. I need to say that this year the EFSD also plans to finance technical assistance to Armenia to ensure that the tax code takes effect.

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